UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549

Form 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES EXCHANGE ACT OF 1934

For quarterly period ended June 30, 2007

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ____________ to _____________
 
Commission File Number: 0-11576

HARRIS & HARRIS GROUP, INC. 
(Exact name of registrant as specified in its charter)
 
New York 
13-3119827 
 (State or other jurisdiction of  incorporation or organization)
(IRS Employer Identification No.)
 
111 West 57th Street, New York, New York 
10019 
(Address of Principal Executive Offices)
 (Zip Code)
 
(212) 582-0900 
(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  x  No  o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Large Accelerated Filer o Accelerated Filer x  Non-Accelerated Filer o 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o  No  x
 
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

Class
Outstanding at August 7, 2007
Common Stock, $0.01 par value per share 
23,198,524 shares
 
 
Harris & Harris Group, Inc.
Form 10-Q, June 30, 2007

     
Page Number
  
PART I.  FINANCIAL INFORMATION
        
       
Item 1. Consolidated Financial Statements
    
1
  
         
Consolidated Statements of Assets and Liabilities
    
2
  
         
Consolidated Statements of Operations
    
3
  
         
Consolidated Statements of Cash Flows
    
4
  
         
Consolidated Statements of Changes in Net Assets
    
5
  
         
Consolidated Schedule of Investments
    
6
  
         
Notes to Consolidated Financial Statements
    
18
  
         
Financial Highlights
    
26
  
         
Item 2. Management's Discussion and Analysis of Financial Condition
        
and Results of Operations
    
27
  
         
Background and Overview
    
27
  
         
Results of Operations
    
30
  
         
Financial Condition
    
33
  
         
Liquidity
    
35
  
         
Capital Resources
    
35
  
         
Critical Accounting Policies
    
36
  
         
Recent Developments - Portfolio Companies
    
37
  
         
Forward Looking Statements
    
38
  
         
Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
38
  
         
Item 4. Controls and Procedures
    
39
  
         
PART II.  OTHER INFORMATION
        
         
Item 1A. Risk Factors
    
41
  
         
Item 4. Submission of Matters to a Vote of Security Holders
    
41
  
         
Item 6. Exhibits
    
42
  
         
Signatures
    
43
  
         
Exhibit Index
    
44
  
 
 

PART I. FINANCIAL INFORMATION

Item 1. Consolidated Financial Statements

The information furnished in the accompanying consolidated financial statements reflects all adjustments that are, in the opinion of management, necessary for a fair statement of the results for the interim period presented.

Harris & Harris Group, Inc.® (the "Company," "us," "our" and "we"), is an internally managed venture capital company that has elected to operate as a business development company under the Investment Company Act of 1940 (the "1940 Act"). Certain information and disclosures normally included in the consolidated financial statements in accordance with Generally Accepted Accounting Principles have been condensed or omitted as permitted by Regulation S-X and Regulation S-K. The accompanying consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto for the year ended December 31, 2006, contained in our Annual Report on Form 10-K for the year ended December 31, 2006.

On September 25, 1997, our Board of Directors approved a proposal to seek qualification as a regulated investment company ("RIC") under Subchapter M of the Internal Revenue Code (the "Code"). At that time, we were taxable under Subchapter C of the Code (a "C Corporation"). We filed for the 1999 tax year to elect treatment as a RIC. In order to qualify as a RIC, we must, in general, (1) annually, derive at least 90 percent of our gross income from dividends, interest, gains from the sale of securities and similar sources; (2) quarterly, meet certain investment diversification requirements; and (3) annually, distribute at least 90 percent of our investment company taxable income as a dividend. In addition to the requirement that we must annually distribute at least 90 percent of our investment company taxable income, we may either distribute or retain our taxable net capital gains from investments, but any net capital gains not distributed could be subject to corporate level tax. Further, we could be subject to a four percent excise tax to the extent we fail to distribute at least 98 percent of our annual investment company taxable income and would be subject to income tax to the extent we fail to distribute 100 percent of our investment company taxable income.

Because of the specialized nature of our investment portfolio, we generally can satisfy the diversification requirements under Subchapter M of the Code if we receive a certification from the Securities and Exchange Commission (“SEC”) that we are "principally engaged in the furnishing of capital to other corporations which are principally engaged in the development or exploitation of inventions, technological improvements, new processes, or products not previously generally available."
 
On June 20, 2007, we received SEC certification for 2006, permitting us to qualify for RIC treatment for 2006 (as we had for the years 1999 through 2005) pursuant to Section 851(e) of the Code. Although the SEC certification for 2006 was issued, there can be no assurance that we will qualify for or receive such certification for subsequent years (to the extent we need additional certification as a result of changes in our portfolio) or that we will actually qualify for Subchapter M treatment in subsequent years. In addition, under certain circumstances, even if we qualified for Subchapter M treatment in a given year, we might take action in a subsequent year to ensure that we would be taxed in that subsequent year as a C Corporation, rather than as a RIC.
 
1
 
HARRIS & HARRIS GROUP, INC.
CONSOLIDATED STATEMENTS OF ASSETS AND LIABILITIES
   
June 30, 2007
  
December 31, 2006
  
   
(Unaudited)
      
ASSETS
          
           
             
$121,331,398 at 12/31/06)
  
$
126,714,999
  
$
112,323,978
  
Cash and cash equivalents
    
2,213,518
    
2,071,788
  
Restricted funds
    
2,325,318
    
2,149,785
  
Receivable from broker
    
151,565
    
819,905
  
Interest receivable
    
585,156
    
625,372
  
Prepaid expenses
    
305,743
    
10,945
  
Other assets
    
288,148
    
326,817
  
Total assets
  
$
132,584,447
  
$
118,328,590
  
               
               
LIABILITIES & NET ASSETS
              
               
Accounts payable and accrued liabilities
  
$
4,344,189
  
$
4,115,300
  
Accrued profit sharing (Note 5)
    
0
    
261,661
  
Deferred rent
    
17,925
    
21,326
  
Total liabilities
    
4,362,114
    
4,398,287
  
               
Net assets
  
$
128,222,333
  
$
113,930,303
  
               
Net assets are comprised of:
              
Preferred stock, $0.10 par value,
              
2,000,000 shares authorized; none issued
  
$
0
  
$
0
  
Common stock, $0.01 par value, 45,000,000 shares authorized at
              
6/30/07 and 12/31/06; 24,970,664 issued at 6/30/07 and
              
22,843,757 issued at 12/31/06
    
249,707
    
228,438
  
Additional paid-in capital (Note 7)
    
154,555,766
    
129,801,201
  
Accumulated net realized loss
    
(9,400,489
)
  
(3,747,912
)
Accumulated unrealized depreciation of investments
   
(13,838,647
)
  
(9,007,420
)
Unrecognized net gain on retirement benefit plans
    
61,527
    
61,527
  
Treasury stock, at cost (1,828,740 shares at 6/30/07
              
and 12/31/06)
    
(3,405,531
)
  
(3,405,531
)
               
Net assets
  
$
128,222,333
  
$
113,930,303
  
               
Shares outstanding
    
23,141,924
    
21,015,017
  
               
Net asset value per outstanding share
  
$
5.54
  
$
5.42
  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
2
 
HARRIS & HARRIS GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
   
Three Months Ended June 30
  
Six Months Ended June 30
  
   
2007
  
2006
  
2007
  
2006 
  
                         
Interest from:
                          
Fixed-income securities
 
$
637,701
  
$
780,265
  
$
1,290,199
  
$
1,582,627
  
Miscellaneous income
    
0
    
5,000
    
0
    
7,500
  
Total investment income
    
637,701
    
785,265
    
1,290,199
    
1,590,127
  
                           
Expenses:
                          
Salaries, benefits and stock-based
                          
compensation (Note 4)
    
2,644,284
    
804,151
    
5,179,050
    
1,590,512
  
Administration and operations
    
357,178
    
406,092
    
738,043
    
728,541
  
Professional fees
    
335,067
    
97,938
    
517,262
    
387,825
  
Rent
    
58,813
    
57,381
    
118,320
    
118,619
  
Directors’ fees and expenses
    
112,157
    
94,900
    
253,353
    
180,802
  
Depreciation
    
15,908
    
16,128
    
31,221
    
32,896
  
Custodian fees
    
5,961
    
2,562
    
11,735
    
12,562
  
Total expenses
    
3,529,368
    
1,479,152
    
6,848,984
    
3,051,757
  
                           
Net operating loss
    
(2,891,667
)
  
(693,887
)
  
(5,558,785
)
  
(1,461,630
)
                           
Net realized gain (loss) from investments:
                          
Realized (loss) gain from investments
    
(8,213
)
  
1,500
    
(8,887
)
  
13,453
  
Income tax expense (Note 6)
    
0
   
9,931
    
84,905
    
19,537
  
Net realized loss from investments
    
(8,213
)
  
(8,431
)
  
(93,792
)
  
(6,084
)
                           
Net increase in unrealized
                          
depreciation on investments:
                          
Change on investments held
    
(1,193,764
)
  
(580,679
)
  
(4,831,227
)
  
(1,469,273
)
Net increase in unrealized
                          
depreciation on investments
    
(1,193,764
)
  
(580,679
)
  
(4,831,227
)
  
(1,469,273
)
                           
Net realized and unrealized loss
                          
from investments
    
(1,201,977
)
  
(589,110
)
  
(4,925,019
)
  
(1,475,357
)
                           
Net decrease in net assets
                          
resulting from operations
  
$
(4,093,644
)
$
(1,282,997
)
$
(10,483,804
)
$
(2,936,987
)
                           
Per average basic and diluted
                          
outstanding share
  
$
(0.19
)
$
(0.06
)
$
(0.49
)
$
(0.14
)
                           
Average outstanding shares
    
21,721,591
    
20,756,345
    
21,500,810
    
20,756,345
  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
3
 
HARRIS & HARRIS GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
   
Six Months Ended June 30, 2007
  
Six Months Ended June 30, 2006
  
             
Net decrease in net assets resulting from operations
  
$
(10,483,804
)
$
(2,936,987
)
Adjustments to reconcile net decrease in net
              
assets resulting from operations to net cash
              
used in operating activities:
              
Net realized and unrealized loss on investments
    
4,840,114
    
1,455,820
  
Depreciation and amortization
    
89,891
    
(476,238
)
Stock-based compensation expense
    
3,422,637
    
115,545
  
               
Changes in assets and liabilities:
              
Restricted funds
    
(175,533
)
  
(212,406
)
Receivable from portfolio company
    
0
    
75,000
  
Receivable from broker
    
668,340
    
0
  
Interest receivable
    
40,216
    
(341,538
)
Prepaid expenses
   
(294,798
)
  
(290,716
)
Other assets
    
20,647
    
0
  
Accounts payable and accrued liabilities
    
228,888
    
170,265
  
Accrued profit sharing
    
(261,661
)
  
(1,897,072
)
Deferred rent
    
(3,401
)
  
(6,276
)
Current income tax liability
    
0
    
(8,282,830
)
               
Net cash used in operating activities
    
(1,908,464
)
  
(12,627,433
)
               
Cash flows from investing activities:
              
Purchase of short-term investments and marketable securities
    
(27,600,155
)
  
(47,340,796
)
Sale of short-term investments and marketable securities
    
18,353,983
    
76,985,257
  
Investment in private placements and loans
    
(10,043,027
)
  
(18,165,017
)
Proceeds from sale of investments
    
0
    
22,188
  
Purchase of fixed assets
    
(13,804
)
  
(8,584
)
               
Net cash (used in) provided by investing activities
    
(19,303,003
)
  
11,493,048
  
               
Cash flows from financing activities:
              
Proceeds from stock option exercises (Note 4)
    
8,360,029
    
0
  
Proceeds from stock offering (Note 7)
    
12,993,168
    
0
  
               
Net cash provided by financing activities
    
21,353,197
    
0
  
               
Net increase (decrease) in cash and cash equivalents:
              
Cash and cash equivalents at beginning of the period
    
2,071,788
    
1,213,289
  
Cash and cash equivalents at end of the period
    
2,213,518
    
78,904
  
               
Net increase (decrease) in cash and cash equivalents
  
$
141,730
  
$
(1,134,385
)
               
             
Income taxes paid
  
$
84,706
  
$
8,302,367
  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
4
 
HARRIS & HARRIS GROUP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS

   
Six Months Ended June 30, 2007
  
Year Ended December 31, 2006
  
   
(Unaudited)
      
             
               
Net operating loss
  
$
(5,558,785
)
$
(7,612,935
)
Net realized (loss) gain on investments
    
(93,792
)
  
258,693
  
Net increase in unrealized depreciation
              
on investments held
    
(4,831,227
)
  
(4,418,870
)
               
               
Net decrease in net assets resulting
              
from operations
    
(10,483,804
)
  
(11,773,112
)
               
               
Changes in net assets from capital
              
stock transactions:
              
               
Issuance of common stock on offering
    
13,000
    
0
  
Issuance of common stock upon the
              
exercise of stock options
    
8,269
    
2,587
  
Additional paid-in capital on common
              
stock issued
    
21,331,928
    
2,612,603
  
Stock-based compensation expense
    
3,422,637
    
5,038,956
  
               
               
Net increase in net assets resulting from
              
capital stock transactions
    
24,775,834
    
7,654,146
  
               
Changes in net assets from adoption
              
of SFAS No. 158
    
0
    
61,527
  
               
Net increase (decrease) in net assets
    
14,292,030
    
(4,057,439
)
               
Net assets:
              
               
Beginning of the period
    
113,930,303
    
117,987,742
  
 
              
 
$
128,222,333
  
$
113,930,303
  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
5
 
HARRIS & HARRIS GROUP, INC.
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2007
(Unaudited)

   
Method of Valuation (3)
 
Shares/ Principal
 
Value
  
                   
net assets at value
                    
                     
Private Placement Portfolio (Illiquid) - 14.02% of net assets
                    
at value
                    
                     
                     
AlphaSimplex Group, LLC (2) — Investment management company
                    
headed by Dr. Andrew W. Lo, holder of the Harris & Harris Group
                    
Chair at MIT
                    
Limited Liability Company Interest
    
(B)
 
  
—
  
$
11,036
  
                     
                     
Exponential Business Development Company (1)(2) — Venture
                    
capital partnership focused on early stage companies
                    
Limited Partnership Interest
    
(B)
 
  
—
   
0
  
                     
                     
Molecular Imprints, Inc. (1)(2) — Manufacturing nanoimprint
                    
lithography capital equipment
                    
Series B Convertible Preferred Stock
    
(B)
  
1,333,333
    
2,000,000
  
Series C Convertible Preferred Stock
    
(B)
  
1,250,000
    
2,500,000
  
Warrants at $2.00 expiring 12/31/11
    
(B)
  
125,000
    
0
  
               
4,500,000
  
                     
Nanosys, Inc. (1)(2)(5) — Developing zero and one-dimensional
                    
inorganic nanometer-scale materials and devices
                    
Series C Convertible Preferred Stock
    
(C)
  
803,428
    
2,370,113
  
Series D Convertible Preferred Stock
    
(C)
  
1,016,950
    
3,000,003
  
               
5,370,116
  
                     
Nantero, Inc. (1)(2)(5) — Developing a high-density, nonvolatile,
                    
random access memory chip, enabled by carbon nanotubes
                    
Series A Convertible Preferred Stock
    
(C)
  
345,070
    
1,046,908
  
Series B Convertible Preferred Stock
    
(C)
  
207,051
    
628,172
  
   
(C)
  
188,315
    
571,329
  
               
2,246,409
  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
6
 
 
HARRIS & HARRIS GROUP, INC.
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2007
(Unaudited)

   
Method of Valuation (3)
  
Shares/Principal
  
Value
  
                   
net assets at value (cont.)
                    
                     
Private Placement Portfolio (Illiquid) - 14.02% of net assets
                    
at value (cont.)
                    
                     
                     
NeoPhotonics Corporation (1)(2) — Developing and manufacturing
                    
optical devices and components
                    
Common Stock
    
(C)
 
  
716,195
  
$
133,141
  
Series 1 Convertible Preferred Stock
    
(C)
  
1,831,256
    
1,831,256
  
Series 2 Convertible Preferred Stock
    
(C)
  
741,898
    
741,898
  
Series 3 Convertible Preferred Stock
    
(C)
  
2,750,000
    
2,750,000
  
Warrants at $0.15 expiring 01/26/10
    
(C)
  
16,364
    
164
  
Warrants at $0.15 expiring 12/05/10
    
(C)
  
14,063
    
140
  
               
5,456,599
  
                     
Polatis, Inc. (1)(2)(5)(10) — Developing MEMS-based optical
                    
networking components
                    
Series A-1 Convertible Preferred Stock
    
(B)
 
  
16,775
    
0
  
Series A-2 Convertible Preferred Stock
    
(B)
  
71,611
    
305,386
  
Series A-4 Convertible Preferred Stock
    
(B)
  
4,774
    
20,359
  
Series A-5 Convertible Preferred Stock
    
(B)
  
7,674
    
63,069
  
 
                
388,814
  
                     
                     
Total Unaffiliated Private Placement Portfolio (cost: $18,124,392)
              
$
17,972,974
  
                     
Total Investments in Unaffiliated Companies (cost: $18,124,392)
              
$
17,972,974
  
 
 
The accompanying notes are an integral part of these consolidated financial statements.
 
7
 
HARRIS & HARRIS GROUP, INC.
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2007
(Unaudited)

   
Method of Valuation (3)
  
Shares/ Principal
  
Value
  
                   
30.79% of net assets at value
                    
                     
Private Placement Portfolio (Illiquid) - 30.79% of net assets
                    
at value
                    
                     
Adesto Technologies Corporation (1)(2)(4)(5) — Developing
                    
semiconductor-related products enabled at the nanoscale
                    
Series A Convertible Preferred Stock
    
(A)
 
  
3,416,149
  
$
1,147,826
  
                     
                     
Ancora Pharmaceuticals Inc. (1)(2)(4)(5) - Developing synthetic
                    
carbohydrates for pharmaceutical markets and for internal
                    
drug development programs
                    
Series B Convertible Preferred Stock
    
(A)
  
909,091
    
800,000
  
Warrants at $1.06 expiring 05/01/08
    
(B)
  
754,717
    
0
  
               
800,000
  
                     
BridgeLux, Inc. (1)(2)(11) — Manufacturing high-power light
                    
emitting diodes
                    
Series B Convertible Preferred Stock
    
(C)
  
1,861,504
    
1,369,974
  
Secured Convertible Bridge Note (including interest)
    
(A)
$
584,795
    
599,970
  
               
1,969,944
  
                     
Cambrios Technologies Corporation (1)(2)(5) — Developing
                    
nanowire-enabled electronic materials for the display industry
                    
Series B Convertible Preferred Stock
    
(C)
  
1,294,025
    
1,294,025
  
Series C Convertible Preferred Stock
    
(C)
  
1,300,000
    
1,300,000
  
               
2,594,025
  
                     
Chlorogen, Inc. (1)(2)(5) — Developing patented chloroplast
                    
technology to produce plant-made proteins
                    
Series A Convertible Preferred Stock
    
(B)
 
  
4,478,038
    
0
  
Series B Convertible Preferred Stock
    
(B)
 
  
2,077,930
    
0
  
Secured Convertible Bridge Note (including interest)
    
(B)
 
$
228,480
    
74,790
  
 
                
74,790
  
                     
Crystal IS, Inc. (1)(2)(5) — Developing single-crystal
                    
aluminum nitride substrates for optoelectronic devices
                    
Series A Convertible Preferred Stock
    
(C)
 
  
391,571
    
305,425
  
Series A-1 Convertible Preferred Stock
    
(C)
 
  
1,300,376
    
1,014,294
  
Warrants at $0.78 expiring 05/05/2013
    
(B)
 
  
15,231
    
0
  
Warrants at $0.78 expiring 05/12/2013
    
(B)
 
  
2,350
    
0
  
   
(B)
 
  
4,396
    
0
  
               
1,319,719 
  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
8
 
HARRIS & HARRIS GROUP, INC.
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2007
(Unaudited)
   
Method of Valuation (3)
  
Shares/ rincipal
  
Value
  
             
30.79% of net assets at value (cont.)
                    
                     
Private Placement Portfolio (Illiquid) - 30.79% of net assets
                    
at value (cont.)
                    
                     
                     
CSwitch, Inc. (1)(2)(5) — Developing next-generation, system-on-
                    
a-chip solutions for communications-based platforms
                    
Series A-1 Convertible Preferred Stock
    
(C)
  
6,700,000
  
$
3,350,000
  
                     
                     
D-Wave Systems, Inc. (1)(2)(5)(13) — Developing high-
                    
performance quantum computing systems
                    
Series B Convertible Preferred Stock
    
(A)
 
  
2,000,000
    
1,880,760
  
Warrants at $0.85 expiring 10/19/07
    
(B)
  
1,800,000
    
0
  
                 
1,880,760
  
                     
Ensemble Discovery Corporation (1)(2)(4)(5) - Developing DNA
                    
Programmed Chemistry for the discovery of new classes
                    
of therapeutics and bioassays
                    
Series B Convertible Preferred Stock
    
(A)
  
1,449,275
    
2,000,000
  
                     
                     
Innovalight, Inc. (1)(2)(5) - Developing renewable energy
                    
products enabled by silicon-based nanomaterials
                    
Series B Convertible Preferred Stock
    
(A)
  
16,666,666
    
2,500,000
  
                     
                     
Kereos, Inc. (1)(2)(5) — Developing emulsion-based imaging
                    
agents and targeted therapeutics to image and treat cancer
                    
and cardiovascular disease
                    
Series B Convertible Preferred Stock
    
(A)
  
545,456
    
1,500,000
  
                     
                     
Kovio, Inc. (1)(2)(5) — Developing semiconductor products
                    
using printed electronics and thin-film technologies
                    
Series C Convertible Preferred Stock
    
(C)
 
  
2,500,000
    
3,125,000
  
 
                    
                     
Lifco, Inc. (1)(2)(4)(5) — Developing energy solutions using
                    
                   
Series A Convertible Preferred Stock
    
(A)
 
  
1,208,262
    
946,528
  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
9
 
HARRIS & HARRIS GROUP, INC.
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2007
(Unaudited)

   
Method of Valuation (3)
  
Shares/Principal
  
Value
  
                   
30.79% of net assets at value (cont.)
                    
                     
Private Placement Portfolio (Illiquid) - 30.79% of net assets
                    
at value (cont.)
                    
                     
                     
Mersana Therapeutics, Inc. (1)(2)(5)(12) — Developing advanced
                    
polymers for drug delivery
                    
Series A Convertible Preferred Stock
    
(C)
 
  
68,451
  
$
136,902
  
Series B Convertible Preferred Stock
    
(C)
  
866,500
    
1,733,000
  
Warrants at $2.00 expiring 10/21/10
    
(B)
  
91,625
    
0
  
               
1,869,902
  
                     
Metabolon, Inc. (1)(2)(5) - Discovering biomarkers through
                    
the use of metabolomics
                    
Series B Convertible Preferred Stock
    
(A)
 
  
2,173,913
    
2,500,000
  
                     
                     
NanoGram Corporation (1)(2)(5) — Developing a broad suite of intellectual
                    
property utilizing nanoscale materials
                    
Series I Convertible Preferred Stock
    
(C)
  
63,210
    
64,259
  
Series II Convertible Preferred Stock
    
(C)
  
1,250,904
    
1,271,670
  
Series III Convertible Preferred Stock
    
(C)
  
1,242,144
    
1,262,764
  
               
2,598,693
  
                     
Nanomix, Inc. (1)(2)(5) — Producing nanoelectronic sensors that
                    
integrate carbon nanotube electronics with silicon microstructures
                    
Series C Convertible Preferred Stock
    
(B)
 
  
9,779,181
    
330,228
  
Series D Convertible Preferred Stock
    
(B)
  
68,023,977
    
680,240
  
               
1,010,468
  
                     
NanoOpto Corporation (1)(2)(5) — Manufacturing discrete and integrated
                    
optical communications sub-components on a chip by utilizing
                    
nano manufacturing and nano coating technology
                    
Series A-1 Convertible Preferred Stock
    
(B)
 
  
267,857
    
0
  
Series B Convertible Preferred Stock
    
(B)
  
3,819,935
    
0
  
Series C Convertible Preferred Stock
    
(B)
  
1,932,789
    
0
  
Series D Convertible Preferred Stock
    
(B)
  
1,397,218
    
0
  
Secured Convertible Bridge Note (including interest)
    
(B)
  
268,654
    
60,000
  
Warrants at $0.4359 expiring 03/15/10
    
(B)
  
193,279
    
0
  
               
60,000
  
                     
Nextreme Thermal Solutions, Inc. (1)(2)(5) — Developing thin-film
                    
                   
Series A Convertible Preferred Stock
    
(B)
  
1,750,000
    
1,750,000
  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
10
 
HARRIS & HARRIS GROUP, INC.
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2007
(Unaudited)

   
Method of Valuation (3) 
    
Shares/ Principal
    
Value 
  
Investments in Non-Controlled Affiliated Companies (6)(8) -
                    
30.79% of net assets at value (cont.)
                    
                     
Private Placement Portfolio (Illiquid) - 30.79% of net assets
                    
at value (cont.)
                    
                     
                     
Questech Corporation (1)(2) — Manufacturing and marketing
                    
proprietary metal and stone decorative tiles
                    
Common Stock
    
(B)
  
655,454
  
$
832,427
  
Warrants at $1.50 expiring 11/21/07
    
(B)
  
3,750
    
0
  
Warrants at $1.50 expiring 11/19/08
    
(B)
  
5,000
    
0
  
Warrants at $1.50 expiring 11/19/09
    
(B)
  
5,000
    
0
  
                 
832,427
  
                     
Solazyme, Inc. (1)(2)(5) — Developing energy-harvesting
                    
machinery of photosynthetic microbes to produce industrial
                    
and pharmaceutical molecules
                    
Series A Convertible Preferred Stock
    
(B)
 
  
988,204
    
385,400
  
Series B Convertible Preferred Stock
    
(B)
 
  
495,246
    
500,000
  
 
                
885,400
  
                     
Starfire Systems, Inc. (1)(2)(5) —Producing ceramic-forming polymers
                    
Common Stock
    
(B)
  
375,000
    
150,000
  
Series A-1 Convertible Preferred Stock
    
(C)
  
600,000
    
600,000
  
                 
750,000
  
                     
Xradia, Inc. (1)(2) - Designing, manufacturing and selling ultra high
                    
resolution 3D x-ray microscopes and fluorescence imaging systems
                    
Series D Convertible Preferred Stock
    
(A)
 
  
3,121,099
    
4,000,000
  
                     
                     
Zia Laser, Inc. (1)(2)(5) — Developing quantum dot semiconductor lasers
                    
Series C Convertible Preferred Stock
    
(B)
 
  
1,500,000
    
15,000
  
                     
                     
                     
                     
Total Non-Controlled Private Placement Portfolio (cost: $49,607,677)
              
$
39,480,482
  
                     
Total Investments in Non-Controlled Affiliated Companies (cost: $49,607,677)
              
$
39,480,482
  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
11
 
HARRIS & HARRIS GROUP, INC.
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2007
(Unaudited)

   
Method of Valuation (3)
  
Shares/ Principal
  
Value
  
Investments in Controlled Affiliated Companies (6)(9) - 1.09%
                    
of net assets at value
                    
                     
Private Placement Portfolio (Illiquid) - 1.09% of net assets
                    
at value
                    
                     
Evolved Nanomaterial Sciences, Inc. (1)(2)(5) — Developing
                    
nanoscale-enhanced approaches for the resolution of
                    
chiral molecules
                    
Series A Convertible Preferred Stock
    
(B)
  
5,870,021
  
$
438,042
  
                     
                     
SiOnyx, Inc. (1)(2)(5) — Developing silicon-based optoelectronic
                    
products enabled by its proprietary "Black Silicon"
                    
Series A Convertible Preferred Stock
    
(C)
  
233,499
    
70,050
  
Series A-1 Convertible Preferred Stock
    
(C)
  
2,966,667
    
890,000
  
                 
960,050
  
                     
                     
Total Controlled Private Placement Portfolio (cost: $4,440,000)
              
$
1,398,092
  
                     
Total Investments in Controlled Affiliated Companies (cost: $4,440,000)
              
$
1,398,092
  
                     
Total Private Placement Portfolio (cost: $72,172,069)
              
$
58,851,548
  
                     
                     
U.S. Government and Agency Securities - 52.93% of net assets at value
                    
                     
U.S. Treasury Bill — due date 07/19/07
    
(J)
  
12,700,000
  
$
12,675,489
  
U.S. Treasury Notes — due date 11/30/07, coupon 4.25%
    
(H)
  
5,050,000
    
5,036,567
  
U.S. Treasury Notes — due date 02/15/08, coupon 3.375%
    
(H)
  
9,000,000
    
8,909,280
  
U.S. Treasury Notes — due date 05/15/08, coupon 3.75%
    
(H)
  
9,000,000
    
8,901,540
  
U.S. Treasury Notes — due date 09/15/08, coupon 3.125%
    
(H)
  
5,000,000
    
4,892,200
  
U.S. Treasury Notes — due date 01/15/09, coupon 3.25%
    
(H)
  
3,000,000
    
2,926,170
  
U.S. Treasury Notes — due date 02/15/09, coupon 4.50%
    
(H)
  
5,100,000
    
5,064,555
  
U.S. Treasury Notes — due date 04/15/09, coupon 3.125%
    
(H)
  
3,000,000
    
2,910,000
  
U.S. Treasury Notes — due date 07/15/09, coupon 3.625%
    
(H)
  
3,000,000
    
2,926,410
  
U.S. Treasury Notes — due date 10/15/09, coupon 3.375%
    
(H)
  
3,000,000
    
2,902,500
  
U.S. Treasury Notes — due date 01/15/10, coupon 3.625%
    
(H)
  
3,000,000
    
2,910,000
  
U.S. Treasury Notes — due date 04/15/10, coupon 4.00%
    
(H)
  
3,000,000
    
2,930,850
  
U.S. Treasury Notes — due date 07/15/10, coupon 3.875%
    
(H)
 
  
3,000,000
    
2,916,330
  
U.S. Treasury Notes — due date 10/15/10, coupon 4.25%
    
(H)
 
  
2,000,000
    
1,961,560
  
                     
                     
Total Investments in U.S. Government and Agency Securities (cost: $68,381,577)
              
$
67,863,451
  
                     
Total Investments (cost: $140,553,646)
              
$
126,714,999
  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
12
 
HARRIS & HARRIS GROUP, INC.
CONSOLIDATED SCHEDULE OF INVESTMENTS AS OF JUNE 30, 2007
(Unaudited)

Notes to Consolidated Schedule of Investments

(1)
Represents a non-income producing security. Equity investments that have not paid dividends within the last 12 months are considered to be non-income producing.

(2)
Legal restrictions on sale of investment.

(3)
See Footnote to Consolidated Schedule of Investments on page 14 for a description of the Valuation Procedures.

(4)
Initial investment was made during 2007.

(5)
These investments are development stage companies. A development stage company is defined as a company that is devoting substantially all of its efforts to establishing a new business, and either it has not yet commenced its planned principal operations, or it has commenced such operations but has not realized significant revenue from them.

(6)
Investments in unaffiliated companies consist of investments in which we own less than five percent of the voting shares of the portfolio company. Investments in non-controlled affiliated companies consist of investments in which we own five percent or more, but less than 25 percent, of the voting shares of the portfolio company, or where we hold one or more seats on the portfolio company’s Board of Directors but do not control the company. Investments in controlled affiliated companies consist of investments in which we own 25 percent or more of the voting shares of the portfolio company or otherwise control the company.

(7)
The aggregate cost for federal income tax purposes of investments in unaffiliated companies is $18,124,392. The gross unrealized appreciation based on the tax cost for these securities is $1,732,194. The gross unrealized depreciation based on the tax cost for these securities is $1,883,612.

(8)
The aggregate cost for federal income tax purposes of investments in non-controlled affiliated companies is $49,607,677. The gross unrealized appreciation based on the tax cost for these securities is $958,456. The gross unrealized depreciation based on the tax cost for these securities is $11,085,651.

(9)
The aggregate cost for federal income tax purposes of investments in controlled affiliated companies is $4,440,000. The gross unrealized appreciation based on the tax cost for these securities is $0. The gross unrealized depreciation based on the tax cost for these securities is $3,041,908.

(10)
Continuum Photonics, Inc., merged with Polatis, Ltd., to form Polatis, Inc.

(11)
BridgeLux, Inc., was previously named eLite Optoelectronics, Inc.
 
(12)
Mersana Therapeutics, Inc., was previously named Nanopharma Corp.

(13)
D-Wave Systems, Inc., is located and is doing business primarily in Canada. We invested in D-Wave Systems, Inc., through D-Wave USA, a Delaware company. Our investment is denominated in Canadian dollars and is subject to foreign currency translation. Refer to Note 3 "Significant Accounting Policies."

The accompanying notes are an integral part of this consolidated schedule.
 
13
 
HARRIS & HARRIS GROUP, INC.
FOOTNOTE TO CONSOLIDATED SCHEDULE OF INVESTMENTS
(Unaudited)

VALUATION PROCEDURES

Our investments can be classified into five broad categories for valuation purposes:

Equity-Related Securities;

Investments in Intellectual Property or Patents or Research and Development in Technology or Product Development;

Long-Term Fixed-Income Securities;

Short-Term Fixed-Income Investments; and

All Other Investments.

The 1940 Act requires periodic valuation of each investment in our portfolio to determine net asset value. Under the 1940 Act, unrestricted securities with readily available market quotations are to be valued at the current market value; all other assets must be valued at "fair value" as determined in good faith by or under the direction of the Board of Directors.

Our Board of Directors is responsible for (1) determining overall valuation guidelines and (2) ensuring the valuation of investments within the prescribed guidelines.

Our Valuation Committee, comprised of all of our independent Board members, is responsible for reviewing and approving the valuation of our assets within the guidelines established by the Board of Directors.

Fair value is generally defined as the amount that an investment could be sold for in an orderly disposition over a reasonable time. Generally, to increase objectivity in valuing our assets, external measures of value, such as public markets or third-party transactions, are utilized whenever possible. Valuation is not based on long-term work-out value, nor immediate liquidation value, nor incremental value for potential changes that may take place in the future.

The values assigned to these investments are based on available information and do not necessarily represent amounts that might ultimately be realized, as these amounts depend on future circumstances and cannot reasonably be determined until the individual investments are actually liquidated or become marketable.
 
14

 
Our valuation policy with respect to the five broad investment categories is as follows:

Equity-Related Securities

Equity-related securities are valued using one or more of the following basic methods of valuation:

A. Cost. The cost method is based on our original cost. This method is generally used in the early stages of a company’s development until significant positive or negative events occur subsequent to the date of the original investment that dictate a change to another valuation method. Some examples of these events are: (1) a major recapitalization; (2) a major refinancing; (3) a significant third-party transaction; (4) the development of a meaningful public market for the company’s common stock; and (5) significant positive or negative changes in a company’s business.

B. Analytical Method. The analytical method is generally used to value an investment position when there is no established public or private market in the company’s securities or when the factual information available to us dictates that an investment should no longer be valued under either the cost or private market method. This valuation method is inherently imprecise and ultimately the result of reconciling the judgments of our Valuation Committee members, based on the data available to them. The resulting valuation, although stated as a precise number, is necessarily within a range of values that vary depending upon the significance attributed to the various factors being considered. Some of the factors considered may include the financial condition and operating results of the company, the long-term potential of the business of the company, the values of similar securities issued by companies in similar businesses, the proportion of the company’s securities we own and the nature of any rights to require the company to register restricted securities under applicable securities laws.

C. Private Market. The private market method uses actual, executed, historical transactions in a company’s securities by responsible third parties as a basis for valuation. The private market method may also use, where applicable, unconditional firm offers by responsible third parties as a basis for valuation.

D. Public Market. The public market method is used when there is an established public market for the class of the company’s securities held by us or into which our securities are convertible. We discount market value for securities that are subject to significant legal and contractual restrictions. Other securities, for which market quotations are readily available, are carried at market value as of the time of valuation. Market value for securities traded on securities exchanges or on the Nasdaq Global Market is the last reported sales price on the day of valuation. For other securities traded in the over-the-counter market and listed securities for which no sale was reported on that day, market value is the mean of the closing bid price and asked price on that day. This method is the preferred method of valuation when there is an established public market for a company’s securities, as that market provides the most objective basis for valuation.
 
15

Investments in Intellectual Property or Patents or Research and Development in Technology or Product Development

These investments are carried at fair value using the following basic methods of valuation:
 
E. Cost. The cost method is based on our original cost. This method is generally used in the early stages of commercializing or developing intellectual property or patents or research and development in technology or product development until significant positive or adverse events occur subsequent to the date of the original investment that dictate a change to another valuation method.

F. Analytical Method. The analytical method is used to value an investment after analysis of the best available outside information where the factual information available to us dictates that an investment should no longer be valued under either the cost or private market method. This valuation method is inherently imprecise and ultimately the result of reconciling the judgments of our Valuation Committee members. The resulting valuation, although stated as a precise number, is necessarily within a range of values that vary depending upon the significance attributed to the various factors being considered. Some of the factors considered may include the results of research and development, product development progress, commercial prospects, term of patent and projected markets.

G. Private Market. The private market method uses actual third-party investments in intellectual property or patents or research and development in technology or product development as a basis for valuation, using actual executed historical transactions by responsible third parties. The private market method may also use, where applicable, unconditional firm offers by responsible third parties as a basis for valuation.

As of June 30, 2007, we do not have any investments in intellectual property or patents or research and development in technologies or products.

Long-Term Fixed-Income Securities

H. Readily Marketable. Fixed-income securities for which market quotations are readily available are carried at market value as of the time of valuation using the most recent bid quotations when available.

I. Not Readily Marketable. Securities for which market quotations are not readily available are carried at fair value using one or more of the following basic methods of valuation:

Fixed-income securities are valued by independent pricing services that provide market quotations based primarily on quotations from dealers and brokers, market transactions, and other sources.

Other fixed-income securities that are not readily marketable are valued at fair value by our Valuation Committee.

Short-Term Fixed-Income Investments

J. Short-term fixed-income investments are valued at market value at the time of valuation. We value short-term debt with remaining maturity of 60 days or less at amortized cost.
 
16

All Other Investments

K. All other investments are reported at fair value as determined in good faith by the Valuation Committee. As of June 30, 2007, we do not have any of these investments.

The reported values of securities for which market quotations are not readily available and for other assets reflect the Valuation Committee’s judgment of fair values as of the valuation date using the outlined basic methods of valuation. They do not necessarily represent an amount of money that would be realized if we had to sell the securities in an immediate liquidation. Thus, valuations as of any particular date are not necessarily indicative of amounts that we may ultimately realize as a result of future sales or other dispositions of investments we hold.
 
17
 
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
NOTE 1. THE COMPANY

Harris & Harris Group, Inc. (the "Company," "us," "our" and "we"), is a venture capital company operating as a business development company ("BDC") under the Investment Company Act of 1940 ("1940 Act"). We operate as an internally managed company whereby our officers and employees, under the general supervision of our Board of Directors, conduct our operations.

We elected to become a BDC on July 26, 1995, after receiving the necessary shareholder approvals. From September 30, 1992, until the election of BDC status, we operated as a closed-end, non-diversified investment company under the 1940 Act. Upon commencement of operations as an investment company, we revalued all of our assets and liabilities in accordance with the 1940 Act. Prior to September 30, 1992, we were registered and filed under the reporting requirements of the Securities Exchange Act of 1934 (the "1934 Act") as an operating company and, while an operating company, operated directly and through subsidiaries.

Harris & Harris Enterprises, Inc.SM ("Enterprises"), is a 100 percent wholly owned subsidiary of the Company. Enterprises is a partner in Harris Partners I, L.P.SM and is taxed under Subchapter C of the Code (a “C Corporation”). Harris Partners I, L.P, is a limited partnership and owns our interest in AlphaSimplex Group, LLC. The partners of Harris Partners I, L.P., are Enterprises (sole general partner) and Harris & Harris Group, Inc. (sole limited partner). Enterprises pays taxes on any non-passive investment income generated by Harris Partners I, L.P. The Company consolidates the results of its subsidiaries for financial reporting purposes.
 
NOTE 2. INTERIM FINANCIAL STATEMENTS

Our interim financial statements have been prepared in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X and in conformity with generally accepted accounting principles applicable to interim financial information. Accordingly, they do not include all information and disclosures necessary for a presentation of our financial position, results of operations and cash flows in conformity with generally accepted accounting principles in the United States of America. In the opinion of management, these financial statements reflect all adjustments, consisting only of normal recurring accruals, necessary for a fair presentation of our financial position, results of operations and cash flows for such periods. The results of operations for any interim period are not necessarily indicative of the results for the full year. These financial statements should be read in conjunction with the financial statements and notes thereto contained in our Annual Report on Form 10-K for the fiscal year ended December 31, 2006.
 
NOTE 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The following is a summary of significant accounting policies followed in the preparation of the consolidated financial statements:
 
Principles of Consolidation. The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for investment companies and include the accounts of the Company and its wholly owned subsidiaries. All significant inter-company accounts and transactions have been eliminated in consolidation.
 
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Use of Estimates. The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and contingent assets and liabilities as of June 30, 2007 and December 31, 2006, and the reported amounts of revenues and expenses for the three months and six months ended June 30, 2007 and 2006. The most significant estimates relate to the fair valuations of certain of our investments. Actual results could differ from these estimates.

Cash and Cash Equivalents. Cash and cash equivalents include money market instruments with maturities of less than three months.
 
Portfolio Investment Valuations. Investments are stated at "value" as defined in the 1940 Act and in the applicable regulations of the SEC. Value, as defined in Section 2(a)(41) of the 1940 Act, is (i) the market price for those securities for which a market quotation is readily available and (ii) the fair value as determined in good faith by, or under the direction of, the Board of Directors for all other assets. (See "Valuation Procedures" in the "Footnote to Consolidated Schedule of Investments.") At June 30, 2007, our financial statements include private venture capital investments valued at $58,851,548, the fair values of which were determined in good faith by, or under the direction, of the Board of Directors. Upon sale of investments, the values that are ultimately realized may be different from what is presently estimated. The difference could be material.

Foreign Currency Translation. The accounting records of the Company are maintained in U.S. dollars. All assets and liabilities denominated in foreign currencies are translated into U.S. dollars based on the rate of exchange of such currencies against U.S. dollars on the date of valuation. For the six months ended June 30, 2007, included in the unrealized depreciation on investments was a $164,316 gain resulting from foreign currency translation.

Securities Transactions. Securities transactions are accounted for on the date the securities are purchased or sold (trade date); dividend income is recorded on the ex-dividend date; and interest income is accrued as earned. The Company ceases accruing interest when securities are determined to be non-income producing and writes off any previously accrued interest. Realized gains and losses on investment transactions are determined by specific identification for financial reporting and tax reporting.

Stock-Based Compensation. The Company has a stock-based employee compensation plan. The Company accounts for the plan in accordance with the provisions of Statement of Financial Accounting Standards ("SFAS") No. 123(R), "Share-Based Payment." See Note 4 for further discussion.

Income Taxes. Prior to our conversion to a RIC in 1999, our taxes were accounted for in accordance with SFAS No. 109, "Accounting for Income Taxes.".
 
We pay federal, state and local income taxes on behalf of our wholly owned subsidiary, Harris & Harris Enterprises, which is a C corporation. (See "Note 6. Income Taxes.")
 
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In June 2006, the FASB issued Interpretation 48, "Accounting for Uncertainty in Income Taxes" (“FIN 48”), an interpretation of SFAS No. 109. FIN 48 clarifies the accounting and reporting for income taxes where interpretation of the law is uncertain. FIN 48 prescribes a comprehensive model for the financial statement recognition, measurement, presentation and disclosure of income tax uncertainties with respect to positions taken or expected to be taken in income tax returns. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company adopted FIN 48 on January 1, 2007, which had no effect on the Company's financial statements. The Company recognizes interest and penalties in income tax expense. See Note 7 for further discussion.

Restricted Funds. The Company maintains a rabbi trust for the purposes of accumulating funds to satisfy the obligations incurred by us for the Supplemental Executive Retirement Plan ("SERP") under the employment agreement with Charles E. Harris.
 
Property and Equipment. Property and equipment are included in "Other Assets" and are carried at cost, less accumulated depreciation of $305,646. Depreciation is provided using the straight-line method over the estimated useful lives of the premises and equipment.

Recent Accounting Pronouncements. In February 2007, the FASB issued Statement No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities" (“SFAS No. 159”). SFAS No. 159 would allow the Company an irrevocable election to measure certain financial assets and liabilities at fair value, with unrealized gains and losses on the elected items recognized in earnings at each reporting period. The fair value option may only be elected at the time of initial recognition of a financial asset or financial liability or upon the occurrence of certain specified events. The election is applied on an instrument-by-instrument basis, with a few exceptions, and is applied only to entire instruments and not to portions of instruments. SFAS No. 159 also provides expanded disclosure requirements regarding the effects of electing the fair value option on the financial statements. SFAS No. 159 is effective prospectively for fiscal years beginning after November 15, 2007. The Company is currently evaluating this Statement. However, as investments are carried at fair value, the Company does not anticipate that this Statement will have a significant impact on the consolidated financial statements.
 
NOTE 4. STOCK-BASED COMPENSATION

On March 23, 2006, the Board of Directors of the Company voted to terminate the Employee Profit-Sharing Plan and establish the Harris & Harris Group, Inc., 2006 Equity Incentive Plan (the “Stock Plan”), subject to shareholder approval. This proposal was approved at the May 4, 2006, Annual Meeting of Shareholders. The Stock Plan provides for the grant of equity-based awards of stock options and restricted stock (subject to receipt of an exemption order described below) to our directors, officers and employees who are selected by our Compensation Committee for participation in the plan and subject to compliance with the 1940 Act.

On July 11, 2006, the Company filed an application with the SEC regarding certain provisions of the Stock Plan, and on July 11, 2007, the Company responded to comments from the SEC on the application. In the event that the SEC provides the exemptive relief requested by the application and we receive any additional stockholder approval required by the SEC, the Compensation Committee may, in the future, authorize awards under the Stock Plan to certain former officers of the Company, non-employee directors of the Company, authorize grants of restricted stock and adjust the exercise price of options to reflect taxes paid for deemed dividends.
 
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A maximum of 20 percent of our total shares of our common stock issued and outstanding are available for awards under the Stock Plan. Under the Stock Plan, no more than 25 percent of the shares of stock reserved for the grant of the awards under the Stock Plan may be restricted stock awards at any time during the term of the Stock Plan. If any shares of restricted stock are awarded, such awards will reduce on a percentage basis the total number of shares of stock for which options may be awarded. If the Company does not receive exemptive relief from the SEC to issue restricted stock, all shares granted under the Stock Plan may be subject to stock options. No more than 1,000,000 shares of our common stock may be made subject to awards under the Stock Plan to any individual in any year.

On June 26, 2006, the Compensation Committee of the Board of Directors of the Company approved individual stock option awards for certain officers and employees of the Company. Both non-qualified stock options ("NQSOs") and incentive stock options ("ISOs"), subject to the limitations of Section 422 of the Internal Revenue Code, were awarded under the Stock Plan. The terms and conditions of the stock options granted were determined by the Compensation Committee and set forth in award agreements between the Company and each award recipient. A total of 3,958,283 stock options were granted with vesting periods ranging from December 2006 to June 2014 and with an exercise price of $10.11. Upon exercise, the shares will be issued from our previously authorized shares. The full Board of Directors ratified and approved the grants on August 3, 2006, on which date the Company's common stock price fluctuated between $9.76 and $10.00.

On June 27, 2007, the Compensation Committee of the Board of Directors of the Company approved a new grant of individual NQSO awards for certain officers and employees of the Company. The grant and exercise price were approved by the full Board of Directors on June 27, 2007. The terms and conditions of the stock options granted were determined by the Compensation Committee and set forth in award agreements between the Company and each award recipient entered into on that date. A total of 1,700,609 stock options were granted with vesting periods ranging from December 2007 to June 2014 and with an exercise price of $11.11, which was the closing volume weighted average price of our shares of common stock on June 27, 2007. Upon exercise, the shares will be issued from our previously authorized but unissued shares.
 
The Company accounts for the Stock Plan in accordance with the provisions of SFAS No. 123(R), “Share-Based Payment,” which requires that we determine the fair value of all share-based payments to employees, including the fair value of grants of employee stock options, and record these amounts as an expense in the Statement of Operations over the vesting period with a corresponding increase to our additional paid-in capital. At June 30, 2007, the increase to our operating expenses was offset by the increase to our additional paid-in capital, resulting in no net impact to our net asset value. Additionally, the Company does not record the tax benefits associated with the expensing of stock options because the Company intends to qualify as a RIC under Subchapter M of the Code.

The amount of stock-based compensation expense recognized in the Consolidated Statements of Operations is based on the fair value of the awards the Company expects to vest, recognized over the vesting period on a straight-line basis for each award, and adjusted for actual forfeitures that occur before vesting. The forfeiture rate is estimated at the time of grant and revised, if necessary, in subsequent periods if the actual forfeiture rate differs from the estimated rate.
 
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The fair value of each stock option award is estimated on the date of grant using the Black-Scholes option pricing model. The stock options granted on June 27, 2007, were awarded in four different grant types, each with different contractual terms. The assumptions used in the calculation of fair value of the stock options granted on June 27, 2007, using the Black-Scholes model for each contract term were as follows:
 
       
Number
  
Expected
  
Expected
  
Expected
  
Risk-free
  
Fair
Value
  
   
Contractual
  
of Options
  
Term
  
Volatility
  
Dividend
  
Interest
  
Per
  
Type of Award
  
Term
  
Granted
  
in Yrs
  
Factor
  
Yield
  
Rates
  
 Share
  
                               
Non-qualified stock options
    
1.5 Years
    
380,000
    
1
    
42.6
%
  
0
%
  
4.93
%
$
2.11
  
Non-qualified stock options
    
2.5 Years
    
600,540
    
2
    
40.1
%
  
0
%
  
4.91
%
$
2.92
  
Non-qualified stock options
    
3.5 Years
    
338,403
    
3
    
44.7
%
  
0
%
  
4.93
%
$
3.94
  
Non-qualified stock options
    
9 Years
    
381,666
    
Ranging from 4.75- 6.28
    
Ranging from 57.8% to 59.9
%
  
0
%
  
Ranging from 4.97% to 5.01
%
  
Ranging from $5.92 to $6.85
  
                                                  
Total
          
1,700,609
                                
 
For the three months and six months ended June 30, 2007, the Company recognized $1,732,456 and $3,422,637 of compensation expense in the Consolidated Statements of Operations, respectively. As of June 30, 2007, there was approximately $12,482,116 of unrecognized compensation cost related to unvested stock option awards. This cost is expected to be recognized over a weighted-average period of approximately 1.60 years.

For the three months ended June 30, 2007, a total of 500,895 options were exercised for total proceeds to the Company of $5,064,045. For the six months ended June 30, 2007, a total of 826,907 options were exercised for total proceeds to the Company of $8,360,029. At June 30, 2007, we had a receivable from our broker of $151,565 for options exercised at the end of June. These funds were received in July 2007.

For the three months and six months ended June 30, 2007, the calculation of the net decrease in net assets resulting from operations per share excludes the stock options because such options were anti-dilutive. The options may be dilutive in future periods in which there is a net increase in net assets resulting from operations, in the event that there is a significant increase in the average stock price in the stock market or significant decreases in the amount of unrecognized compensation cost.
 
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A summary of the changes in outstanding stock options is as follows:
 
           
Weighted
  
Weighted
      
       
Weighted
  
Average
  
Average
      
       
Average
  
Grant
 
Remaining
  
Aggregate
  
       
Exercise
  
Date
  
Contractual
  
Intrinsic
  
   
Shares
  
Price
  
Fair Value
  
Term (Yrs)
  
Value
  
                       
Options Outstanding at January 1, 2007
    
3,699,611
 
$
10.11
  
$
4.43